1
Fundamentals of Investing, 13e (Smart)
Chapter 9 Market Efficiency and Behavioral Finance
9.1 Learning Goal 1
1) In an efficient market, the only means of achieving high returns is to invest in high-risk
securities.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: Previous Edition
Learning Goal: Learning Goal 1
2) The efficient market hypothesis means that trades can be executed quickly, easily, and
inexpensively.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: Previous Edition
Learning Goal: Learning Goal 1
3) If a company’s revenues and earnings are highly predictable, it’s stock price will also be
highly predictable.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: Previous Edition
Learning Goal: Learning Goal 1
4) Historically higher returns on the stocks of small companies can be completely explained by
their higher risk.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: Previous Edition
Learning Goal: Learning Goal 1
2
5) Investors skilled in exploiting behavioral errors and market anomalies can consistently
outperform the market by a wide margin.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: Previous Edition
Learning Goal: Learning Goal 1
6) Even if weak form market efficiency is true, it does not mean that studying charts of past
prices and searching for repeating pattern is useless.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: New Question
Learning Goal: Learning Goal 1
7) Even if the semi-strong version of the efficient market hypothesis is true, it might be possible
to earn extraordinary returns from private information not available to other investors.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: New Question
Learning Goal: Learning Goal 1
8) An efficient market reflects
A) only historical information.
B) only the information related to events that have already occurred.
C) all publicly known information related to past events and announced future events.
D) all information including predictions about future information.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: Previous Edition
Learning Goal: Learning Goal 1
3
9) A type of mutual fund with particular appeal to investors who accept the efficient market
hypothesis is
A) index fund.
B) asset allocation fund.
C) growth opportunities fund.
D) emerging markets fund.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: Previous Edition
Learning Goal: Learning Goal 1
10) In an efficient market, prices appear to move randomly because
A) investors do not process new information correctly.
B) only new information affects stock prices.
C) insider trading has an unpredictable effect on stock prices.
D) the number of investors who can forecast prices correctly is too small to have any effect.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: Previous Edition
Learning Goal: Learning Goal 1
11) The efficient market hypothesis rests on which of the following assumptions?
I. Information is widely available to all investors almost simultaneously.
II. Investors react quickly to new information.
III. Investors correctly interpret all available information.
IV. Events which affect the market occur randomly.
A) I and II only
B) I, II and III only
C) II, III and IV only
D) I, II, III and IV
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: Previous Edition
Learning Goal: Learning Goal 1
4
12) Which one of the following activities is likely to be useful if the market is only weak form
efficient?
A) attempting to find the best times to buy and sell
B) attempting to find repeating pattern in stock price behavior
C) attempting to determine if stock prices have upward or downward momentum
D) None of the above would be useful.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: New Question
Learning Goal: Learning Goal 1
13) Which of the following activities would be most useful in an efficient market?
A) buying and holding a diversified portfolio
B) searching for patterns in charts based on stock price movements
C) analyzing financial ratios based on accounting data
D) buying only securities that have performed well in the recent past
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: Previous Edition
Learning Goal: Learning Goal 1
14) Followers of the efficient market hypothesis believe that
A) very few investors actually analyze or evaluate stocks before they make a purchase decision.
B) the needed information to assess the market is available only to corporate insiders.
C) investors react quickly and accurately to new information.
D) individual traders can have a significant impact on the price of a security.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: Previous Edition
Learning Goal: Learning Goal 1
5
15) The weak form of the efficient market theory contends that
A) past price performance is useless in predicting future price movements.
B) past performance can help determine the general direction of future price movements.
C) any publicly available information is useless in predicting future price movements.
D) price movements are not random but follow a general trend over a period of time.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: Previous Edition
Learning Goal: Learning Goal 1
16) According to the semi-strong form of the efficient market hypothesis, which of the
following might lead to extraordinary profits?
A) studying charts of a stock’s past price behavior
B) thoroughly analyzing the state of the economy, the industry and the company’s fundamentals
C) possessing private information not available to other investors
D) carefully timing trades to buy when the price is low and sell when the price is high
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: Previous Edition
Learning Goal: Learning Goal 1
17) The strong form of the efficient market hypothesis contends that
A) a select few institutional investors can earn abnormal profits.
B) abnormal profits are randomly distributed.
C) no one can consistently earn a profit.
D) no one can consistently earn abnormal profits.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: Previous Edition
Learning Goal: Learning Goal 1
6
18) Security markets have been described as random walks and efficient markets. What does
each of these terms mean and how do they relate to the stock market? What makes a market
efficient and what are the consequences of efficiency for fundamental and technical analysis?
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: Previous Edition
Learning Goal: Learning Goal 1
9.2 Learning Goal 2
1) For most companies, the stock price follows the same seasonal pattern as revenues and
earnings.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: Previous Edition
Learning Goal: Learning Goal 2
2) If stock prices move randomly, charting and technical analysis are useful investment tools.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: Previous Edition
Learning Goal: Learning Goal 2
3) The process of buying an underpriced security and selling an equivalent overpriced security
until the prices converge is known as arbitrage.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: New Question
Learning Goal: Learning Goal 2
7
4) Even if the semi-strong form of the efficient market hypothesis is true, trading on illegal
insider information may lead to abnormal profits.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: Previous Edition
Learning Goal: Learning Goal 2
5) The apparent randomness of stock price movements is powerful evidence against market
efficiency.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: New Question
Learning Goal: Learning Goal 2
6) Followers of the random walk hypothesis believe that
A) security analysis is the best tool to utilize when investing in the stock market.
B) the price movements of stocks are unpredictable, and therefore security analysis will not
help to predict future market behavior.
C) that traders can earn higher than normal returns by exploiting market anomalies such as the
small-firm effect.
D) support levels and resistance lines, when combined with basic chart formations, yield both
buy and sell signals.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: Previous Edition
Learning Goal: Learning Goal 2
7) Which one of the following statements concerning the random walk hypothesis is correct?
A) Stock price movements are predictable but only over short periods of time.
B) Random price movements support the weak form efficient market hypothesis.
C) Stock prices in general follow repetitive patterns but the actions of individual investors are
random in nature.
D) Random price movements indicate that investors can earn abnormal profits on a routine
basis.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: Previous Edition
Learning Goal: Learning Goal 2
8
8) The process that quickly eliminates price discrepancies in efficient markets is known as
A) arbitration.
B) market correction.
C) arbitrage.
D) random fluctuation.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: New Question
Learning Goal: Learning Goal 2
9) The random walk hypothesis
A) implies that security analysis is unable to predict future market behavior.
B) suggests that random patterns appear but only over long periods of time.
C) has been disproved based on recent computer simulations.
D) accounts for market anomalies such as calendar effects.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: Previous Edition
Learning Goal: Learning Goal 2
10) There is evidence to support the contention that company insiders
A) cannot earn abnormal profits because they are not permitted to trade shares in their
company’s stock without a one-month advance notice to the SEC.
B) can profit in a manner that counters the strong form of the efficient market hypothesis.
C) generally earn a profit equal to that of public investors.
D) have no distinct advantage when trading shares of their company’s stock.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: Previous Edition
Learning Goal: Learning Goal 2
9
11) Which of the following is true?
A) Historically, high P/E or growth stocks have outperformed low P/E or value stocks.
B) Historically, low P/E or value stocks have outperformed high P/E or growth stocks.
C) After adjusting for risk, high P/E or growth stocks and low P/E or value stocks have
performed about the same over time.
D) the P/E effect is limited to U.S. stocks.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: Previous Edition
Learning Goal: Learning Goal 2
12) Market anomalies are caused by
A) investors’ efforts to avoid or postpone taxes.
B) different levels of risk.
C) statistical quirks.
D) some poorly understood combination of factors.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: Previous Edition
Learning Goal: Learning Goal 2
13) Which one of the following statements is correct?
A) The weekend effect states that security prices tend to rise between Friday afternoon and
Monday morning.
B) The market responds immediately to reflect the information contained in quarterly earnings
reports.
C) Low P/E stocks tend to outperform high P/E stocks on a risk-adjusted basis.
D) The market fully anticipates the information contained in an earnings announcement prior to
the actual announcement.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: Previous Edition
Learning Goal: Learning Goal 2
10
14) Believers in efficient markets tend to explain away market anomalies as
I. random occurrences that create an illusion of causality.
II. errors resulting from inaccurate measures of risk.
III. the result of illegal price manipulation by corporate insiders.
IV. the effect of normal human emotions such as fear and greed.
A) I and II only
B) I, II and III only
C) I and III only
D) I, II, III and IV
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: New Question
Learning Goal: Learning Goal 2
9.3 Learning Goal 3
1) Behavioral finance suggests that investors react to new information in an efficient manner
such that security prices accurately reflect the new information.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: Previous Edition
Learning Goal: Learning Goal 3
2) Fund managers tend to have too little confidence in their abilities leading them to be
excessively cautious.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: Previous Edition
Learning Goal: Learning Goal 3
3) Individuals tend to invest in mutual funds that have recently been performing well.
AACSB: 8 Application of knowledge (Able to translate knowledge of business and management
into practice)
Question Status: Previous Edition
Learning Goal: Learning Goal 3